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What is a Holding Company and When Should You Set One Up?

Key takeaways:

  • A holding company is a type of business entity (“parent company”) that owns a controlling interest in other companies, which are called subsidiaries.
  • The parent corporation can control the subsidiary’s policies and oversee management decisions but doesn’t run day-to-day operations.
  • The advantages of holding companies include asset protection, tax benefits, and support to claim the Lifetime Capital Gains Exemption
  • There are some costs and administrative efforts associated with holding companies
  • Having clear objectives for why you want to incorporate will be helpful in making your decision and knowing when to take the first step

When starting a business, whether its product or service driven, most people start off with an operating company. While there are many ways to set up the ownership structure of your business, it’s important to know the difference between an operating company vs. a holding company, and the roles that each play in a successful business structure.

In this article, we’ll go over what a holding company is, the benefits of setting one up, and how to know when you should set one up.

What is a Holding Company?

A holding company is a business entity, often called an “umbrella” or parent company, that is primarily used for holding investments. In contrast to an operating company that actively manufactures products, offers services, or conducts any other business operations, a holding company typically exists for the sole purpose of controlling other companies, also known as its subsidiaries. Holding companies may also own property, such as real estate, patents, trademarks, stocks, and other assets.

Although a holding company owns the assets of other companies, it often only maintains oversight capacities. So while it may oversee the company’s management decisions, it does not actively participate in running a business’s day-to-day operations of these subsidiaries.

Advantages of a Holding Company

There are many benefits for setting up a holding company for your business.

Asset Protection

One of the primary benefits of a holding company is the protection it offers for the assets it holds.

Holding assets under a holding company, rather than an operating company, adds an extra level of protection. Since assets would be separate from the main operating company, creditors would not be able to seize them in the event that the operating company goes bankrupt. While the holding company may suffer a capital loss and decline in net worth if its subsidiary goes bankrupt, creditors cannot pursue the holding company for remuneration, ultimately limiting the financial liabilities of your business.

There’s also an additional layer of protection that a holding company can offer. It provides a layer of separation between shareholders and the operating company. This means that personally-owned assets such as a family home, would be protected in any litigation against the operating company, including debt liabilities, lawsuits and other risks.

Tax Savings & Deferrals

Another significant advantage of a holding company is the many tax benefits that it offers. An operating company can pay tax-free dividends to its holding company. These dividends can be reinvested into the business, thereby increasing overall cash flow for additional revenue. The dividends can also be held by the holding company for a longer period of time and withdrawn when the owner is part of a lower tax bracket.

In contrast, if these dividends were paid out to shareholders, they would be subject to income tax. In this case, the amount of tax savings can vary based on personal income, type of income, and the province, so it’s wise to consult a tax accountant to maximize savings.

Help claim the Lifetime Capital Gains Exemption

The Lifetime Capital Gains Exemption (LCGE) allows business owners to avoid paying taxes on capital gains income up to a certain amount when they sell shares in their business. To utilize the gains exemption, the shares of the business that are being sold must “qualify” as Qualified Small Business Shares (QSBC). Among many of the criteria that the business must meet, one of them is that they can’t have more than $10 million cash or assets in the corporation.

One way to ensure that you meet this criteria is to pay out any excess cash to a holding company through tax-free dividends. By using a holding company, business owners can split the cash assets from the operating company and take advantage of the LCGE.

Disadvantages of a Holding Company

While holding companies can be a great business move in many cases, they may also come with some downsides.

Costs of Incorporation

Incorporating your business into a holding company has costs involved, including lawyer fees for the initial set up as well as filing fees, accountant fees, treasury and reporting fees, and corporate tax compliance on an ongoing basis. While a holding company would likely have limited activity, it is still important to be aware of all the expenses that can come with owning a secondary company.

Increased Administrative Efforts

Having a holding company requires attention and time commitment to upkeep. There are annual legal and tax filings that must be complied to in order to keep in good standing with the authorities.

When Should You Set up a Holding Company?

In addition to considering all the advantages and disadvantages of a holding company, it’s important to consider your objectives with creating one to know when is the right time to do so.

If you’re looking to defer tax because your operating company has a high cash flow and earning excess cash, it would be a good time to have a holding company. Similarly, if you anticipate any risk, whether financial or legal, and you have a large number of personal assets, it may be a good idea to have a holding company to protect your assets before they’re seized.

Once you can cover the costs to set up and maintain a holding company, you may be in a good position to set one up. The first step would be to talk to the experts, such as a financial advisor or a tax accountant, to be aware of all the costs that need to be considered.

FShad CPA Professional Corporation can support you in setting up your holding company. We’ll help you navigate through the many factors that affect your tax payments, including the province you live in, your personal income, and whether or not it’s beneficial for you to incorporate.

Book a consultation today and get started with our team of expert accountants!

FShad CPA Professional Corporation

Call us at +1 (844) 655-6487 or send us an email to info@shadcpa.ca

Woodbridge, ON